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How inflation impacts insurance: the complete guide for Australian businesses

Your one-stop guide to understanding the importance of accurately declared values and business interruption reviews

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Updated July 2026

A cheaper premium is not the same as better protection

Closing the gap in a soft market

Pacific commercial insurance rates fell 12% in Q1 2026. For many businesses, renewal conditions feel more positive than they have in years. But falling premiums can create a false sense of security and do not mean your insurance program remains adequate. While rates have softened, the cost of replacing, rebuilding and recovering from a loss continues to rise. Australian CPI reached 4.6% in the year to March 2026, the highest rate since September 2023. It eased marginally to 4.0% for the year to May 2026. However, the Reserve Bank of Australia’s preferred measure of underlying inflation, the trimmed mean, unexpectedly rose to 3.6% over the same period. Construction sector inflation is forecast to reach 6% by mid-2026.

Insurance rates and replacement costs are moving in opposite directions. That gap creates an underinsurance risk that will typically not appear at renewal time. It’s often discovered at claim time.

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Key takeaways: Insurance and inflation in 2026

  • Pacific insurance rates fell 12% in Q1 2026, but replacement costs continue to rise, widening the underinsurance gap.
  • The average clause can reduce claim payouts proportionally, including for partial losses.
  • Common mistakes made by businesses during insurance renewal include using CPI to update property and asset values, rolling forward last year’s figures or declaring assets at market value instead of reinstatement cost.
  • Business interruption indemnity periods set two to three years ago may no longer be adequate due to supply chain disruption and specialist trade shortages.
  • Best practice includes professional valuations every two to three years and annual reviews of indemnity periods.

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Why accurate declared values matter more in a soft market

In a soft market, it is easy to let declared values drift. Premiums are falling and renewals feel straightforward. But the cost of replacing and reinstating assets has not softened in line with insurance rates. The good news of a soft market can mask a hidden problem that could compromise the value of your insurance policy.

Underinsurance occurs when the declared value of an asset is lower than its reinstatement or replacement cost. When this happens, claim payouts may be reduced proportionally under the average clause. This applies to partial losses as well as total losses.

How the average clause works

A building insured for $10 million suffers $5 million in fire damage. The property insurer determines the true replacement cost is $20 million. This means the building is 50% underinsured. Consequently, the insurer reduces the claim payout proportionally  by 50% to only $2.5 million.

Partial losses are far more common than total losses. This is where underinsurance is most often exposed.

What is driving replacement costs higher

Inflation remains elevated

  • Australian CPI eased to 4.0% for the year to May 2026, while the Reserve Bank of Australia’s preferred measure of underlying inflation, the trimmed mean, rose to 3.6% (ABS).
  • New Zealand CPI sits at 3.1% for the year to March 2026, above the RBNZ target ceiling.
  • Construction sector inflation is forecast to reach 6% by mid‑2026 (Barrenjoey).

Geopolitical conflict and supply chain disruption

Conflict in the Middle East has disrupted shipping through the Strait of Hormuz, pushing fuel and freight costs higher and flowing directly into Australian construction costs.

Diplomatic progress in June 2026 signals potential de‑escalation, but elevated costs and supply chain disruption will take time to unwind.

Diesel is embedded in nearly every stage of construction. More than 75% of heavy construction equipment relies on diesel for transport, plant and site operations, making the sector highly exposed to fuel price volatility.

Material cost pressures

  • Plastic pipe products used in plumbing, drainage and HVAC are up to 36% higher.
  • Concrete, cement and sand costs continue to rise.
  • Copper and electrical products remain under significant upward pressure.

Specialist trade shortages

The construction industry is facing a labour crisis. According to Australian Securities and Investments Commission data, construction insolvencies have risen sharply since 2021, with 2,965 companies entering administration in FY2023. The construction sector accounted for 28% of all corporate insolvencies.

As capacity tightens and specialist trades become scarcer, repair timelines extend. When repair timelines extend, business interruption exposure increases.

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Common underinsurance mistakes

Most underinsurance issues develop gradually.

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Using CPI to update values

CPI measures economy‑wide inflation, not the cost of replacing specific assets.
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Index linking from an inaccurate starting point

Indicies are broad and do not capture the specific attributes of an asset. If the original sum insured was too low, indexation compounds the gap.
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Declaring assets at market value

Insurance responds on a reinstatement basis, not market value.

Business interruption: the underestimated risk

Business interruption insurance covers loss of income following an insured event. It remains one of the most under‑declared areas of many insurance programs.

If reinstatement takes longer because specialist trades are scarce, indemnity periods must reflect that reality. If restoration costs rise, declared BI values must also increase.

Why indemnity periods are falling short

Recent claims show indemnity periods often fail to allow for:

  • Investigation, specialist access and regulatory approvals
  • Design lead times and compliance changes
  • Material and equipment sourcing delays
  • Repair and reinstatement under labour constraints
  • Return to pre‑loss trading conditions

When setting an indemnity period, businesses should allow time for disruption, not best‑case assumptions.

Contingent business interruption

For many organisations, the greater risk is disruption at a supplier, customer or critical infrastructure provider.

Key exposures include supplier loss, customer site damage, utilities failure and prevention of access without physical damage.

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Your renewal checklist

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Are your declared values accurate?

Do they reflect current construction costs and labour rates?

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Have you checked the indexation trap?

Indexation increases risk if the starting figure is wrong.

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Are your indemnity periods still adequate?

Repair timelines have lengthened across many industries.

 

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Are your policy limits sufficient?

Limits set before recent cost increases may no longer be enough.

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Use our insights to support your next insurance renewal, including:

  • Detailed cost driver analysis
  • Average clause case studies
  • Business interruption calculation framework
  • Renewal timing and broker discussion prompts
  • Expert insights from Marsh’s Risk Consulting team

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FAQs

Market value and reinstatement or replacement cost measure very different things. Confusing the two is one of the most common causes of underinsurance.

Market value is what an asset would sell for in the open market. It is influenced by supply and demand, location, condition, investor sentiment, and buyer willingness to pay.

Replacement value, also known as replacement cost or reinstatement cost, is the amount required to rebuild or replace the specific asset as new. It is driven by current construction costs, labour rates, materials prices, professional fees, and compliance with today’s building standards.

For insurance purposes, assets should be insured at replacement cost, not market value.

Market value vs replacement cost

Market value Reinstatement or Replacement cost
What you could sell the asset for What it costs to rebuild or replace
Influenced by the property market Influenced by the construction market
Includes land value Excludes land value, as land is not insured
Can rise or fall with demand Based on actual rebuild costs
Used for buying and selling Used for insurance coverage

Example

A commercial building in a declining area may have a market value of $5 million, but a replacement cost of $8 million because construction costs have not fallen.

Conversely, a building in a high‑demand location may have a market value of $12 million, while its replacement cost remains $8 million.

The two values often move independently of each other.

Why this matters for insurance

Insurance policies respond on a replacement cost basis. If you declare market value and it is lower than the true replacement cost, your business may be underinsured.

In the event of a claim, this can trigger the average clause, reducing claim payments proportionally, including for partial losses.

This is why market value should never be used as a proxy for insurance values.

Replacement value, also called reinstatement cost, represents what it would cost today to rebuild or replace the specific insured asset as new. It is calculated by assessing several key components.

  1. Construction costs
    Current labour rates, materials prices, contractor availability and margins in the asset’s location.
  2. Asset‑specific characteristics
    Building size, construction type, layout, finishes, services and specifications.
  3. Compliance requirements
    Current building codes, safety standards and environmental regulations, not those in place when the asset was originally built.
  4. Professional fees
    Architects, engineers, project managers, certifiers and approval costs.
  5. Demolition and site preparation
    Debris removal, temporary works, site access and enabling works.
  6. Cost escalation during reinstatement
    Expected price movements over the policy period and likely reconstruction timeline.

Replacement value is not based on purchase price, market value or depreciated book value.

Professional insurance valuers use industry cost guides, local construction data and specialist expertise to calculate accurate reinstatement costs. For complex assets or large portfolios, engaging a qualified insurance valuer helps ensure declared values reflect current conditions and meet insurer expectations.

A provision within the property insurance policy that reduces claim payouts proportionally when assets are under‑declared.

No. CPI does not reflect asset‑specific replacement costs.

Values need to be reviewed for every insurance renewal either annually or mid-year. It is recommended that professional insurance valuations be undertaken every two to three years.

Cover for income loss caused by damage to third‑party property your business depends on.

Underinsurance can reduce claim payouts by 20-50% or more, depending on the level of underinsurance E.g. A $5 million claim on a building that is 50% underinsured would be reduced to a $2.5 million payout.

This publication is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Marsh shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein. Marsh makes no representation or warranty concerning the application of policy wordings or the financial condition or solvency of insurers or re-insurers. Marsh makes no assurances regarding the availability, cost, or terms of insurance coverage.

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